Will Privatizing Social Security Impact Your Retirement?

April 1st, 2005

As I write this, the proposal to “privatize” Social Security changes daily. With all the press this issue is receiving, many of you may be concerned about how it could affect you, now and in the future.

Background
On February 1, 2005, The Wall Street Journal reported that in 1960 there were five workers for every Social Security beneficiary. Today there are slightly more than three. In thirty years there will be two. If tax rates and benefits remain as they are under the current law, the Social Security system will begin paying out more than it collects in 2018. Actuaries estimate that, if changes are not made, benefits will have to be cut 30% in 2042 to maintain the system.

Why the urgency?
Although Social Security can pay promised benefits for many years, workers need time to save more if benefits will be cut and notice if the retirement age is going to change. The longer the government delays, the bigger the tax increases or benefit cuts will be.

What is the private account option?
President Bush is proposing “private accounts.” Under his plan:

Initial retirement benefits for all workers will shrink.

Workers under age 55 could divert about one third of their payroll taxes (up to $1,000) to invest in mutual funds.

Government-paid Social Security benefits to workers with private accounts woud be reduced further, to reflect taxes diverted to private accounts.

At retirement, workers would get access to the money in their private accounts (more or less than they would under traditional Social Security, depending on how their mutual funds perform).

Would private accounts stabilize Social Security?
In the short run, the government would have to find $1 trillion to $2 trillion over the next 10 years (to replace tax revenues diverted to private accounts) to pay current retirees. Over the long run, private accounts are a wash. Diverting payroll taxes to private accounts would reduce the flow of tax money into the system in exchange for reducing government benefits for workers with private accounts. Therefore, private accounts will not fix Social Security’s financing problems; other measures will have to be taken.

How do we stabilize Social Security?
There are a several basic ways to stabilize the system:

Increase the payroll tax (currently 12.4%: 6.2% for employees and 6.2% for employers)

Increase the full-retirement age

Increase the payroll-tax income limit (currently $90,000)

Decrease benefits

Change the formula used to calculate benefits

Most of the alternatives circulating include some combination of these alternatives. No single measure will be significant enough to stabilize Social Security.

Who will be affected?

Current retirees and those over 55 — Under the commission’s plan, only those under 55 will be eligible for private accounts. For current retirees and those 55 and older, there is no change to the current system. However, some proposals would change the costof- living adjustments to Social Security benefits, which could impact this group. People who are planning to retire within the next five years will want to watch this issue closely, particularly as they determine their retirement spending levels.

Younger workers — The bulk of the changes proposed will affect this group. It is likely that they will pay more into the system while working and may receive less guaranteed benefits in retirement. This makes it more important than ever for people to start planning early.

Conclusion
It will be some time before a clear picture of the changes (if any) to the Social Security system emerges and before changes are implemented. There is no reason to believe that the system will go away, and currently the worst-case scenario is that benefits will be cut 30% in 2042. We will keep you updated on the changes and their impact on your retirement.